Risks and Opportunities: The Economic Effects of Federal Interest Rates

You might often see headlines about the U.S. government not being able to balance its budget, which means the national debt keeps growing every year. Concerned investors fear that the mushrooming debt and higher interest rates spell doom for America. This problem has been around for over 20 years and affects both political parties. It’s not getting any better. I recently read an article published by Mitch Zacks, Senior Portfolio Manager for Zacks Investment Management. Let me summarize some of the points of the article along with my own opinions on what is happening.

Investors worry that the ballooning US debt might hurt our economy and markets, throwing us into a recession or worse. With high interest rates, the government could end up spending a bigger part of its tax revenue just on interest payments. This means there would be less money for other things, which could slow down economic growth.

Bigger deficits means the U.S. government has to sell more Treasury bonds to cover its yearly expenses. As of June 30, the U.S. Treasury market has issued $14 trillion in bonds, which is a 41.3% increase from the previous year. In 2023, over $21 trillion in bonds were issued, setting a record, and 2024 is on track to break that record. That sounds really bad. The first cracks we should see if the world is concerned about the safety and stability of the United States would be rising interest rates on US bonds.

However, despite the growing debt and more bonds being issued, Treasury yields have actually gone down since October 2023. If the U.S.’s worsening fiscal situation was becoming a major concern for global markets, one might expect investors to demand higher yields on Treasurys as debt continued to rise. But the opposite has happened over the past 10 months. The last time the U.S. had a budget surplus, which means that the government was actually spending less than the revenue it had coming in was in the late 1990s and early 2000s. At that time the 10-year Treasury bond yield was a bit higher than it is now indicating that the world does not see US debt as a major concern..

Let me be clear, this doesn’t mean that deficits and debt don’t matter—they do. But if they were a serious problem, we’d see warning signs in Treasury yields. Interest rates would be rising, but they aren’t. One reason is that the size of the deficit and national debt aren’t the only things that affect Treasury bond yields. Global demand for U.S. Treasury bonds is also important. Long-term Treasurys currently offer a good return with very little risk if held to maturity. Compared to other low risk options, U.S. Treasurys look very attractive. In 2023, about $190 trillion in U.S. Treasurys were traded. In comparison, Germany, which is considered a strong economy, had about $7 trillion in Treasury trades.

U.S. Treasurys not only offer better yields than many other countries but are also easier to trade. Investors can buy or sell large amounts of Treasurys at any time. These qualities keep demand high, which supports prices and keeps yields low. This shows that rising deficits alone aren’t enough to hurt U.S. economic growth.

Let me be clear,  mounting deficits and national debt should not be written off as insignificant.  Rising deficits during a period of high interest rates can drive up interest costs as a percent of GDP, which can crowd out more productive government spending and serve as a significant drag on economic growth. But it’s also my view that the U.S.’s current fiscal situation is not in a state that’s likely to be harmful to growth in the short to medium term. Interest rates in the late 1970s and early 1980s pushed interest costs as a percent of GDP to levels much higher than we’re seeing today, and the U.S. economy managed to work its way through it.

This is an issue to keep an eye on in the coming months and years, but for now, global investors do not seem to be concerned about the level of debt that the US treasury has issued. Thank you for the confidence that you have placed in me and my team. We work hard to stay informed about current economic conditions like the federal debt and it’s implications on your portfolio. If you like this video please recommend it a friend or refer them to our web site for a free consultation.